Management of        Working Capital
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Management of working capital

Management of Working Capital


Management of working capital

learning objectivesworking capital and working capital requirementthe operating cycleFlatco plc balance sheet as at 31 December 2005Flatco plc profit and loss account for the year ended 31 December 2005working capital policy stocks management just in time (JIT), materials requirement planning (MRP), and optimised production technology (OPT)

Session Summary (1)


Management of working capital

debtors and credit managementexample of an aged debtors reportcreditors managementexample of an aged creditors reportoperating cycle performancebalance sheet items that impact on short-term andlong-term cash flowcash management

Session Summary (2)


Management of working capital

explain what is meant by working capital and theoperating cycledescribe the management and control of the working capital requirementoutline some of the working capital policies that may be adopted by companiesimplement the systems and techniques that may be used for the management and control of stocks, and optimisation of stock levels

Learning Objectives (1)


Management of working capital

outline a system of credit management and the controlof debtorsconsider the management of creditors as an additional source of financeuse the operating cycle to evaluate a company’s working capital requirement performanceconsider the actions and techniques to achieve short-term and long-term cash flow improvement

Learning Objectives (2)


Management of working capital

working capital requirement, WCR= stocks + debtors – creditors – accruals + prepaymentsthe difference between working capital (WC) and working capital requirement (WCR) is cash less short-term financial debt (bank overdraft) WC = WCR - short-term debt + cash

Working Capital and Working Capital Requirement


Management of working capital

the operating cycle relates to working capital (WC), thenet of current assets less current liabilitiesthe operating cycle is the period of time, which elapses between the point at which cash begins to be expendedon the production of a product, and the collection ofcash from the customer

The Operating Cycle (1)


Management of working capital

The Operating Cycle (2)


Management of working capital

Flatco plc Balance Sheet as at 31 December 2005


Management of working capital

Flatco plc Profit and Loss Account for the Year Ended 31 December 2005


Management of working capital

the working capital requirement is normally financed by bank overdraft because ofits flexibility in accommodating the fluctuating nature of net current assetsthe general lower cost of short-term financing the working capital policy adopted depends on individual company objectives and there is inevitably a conflict between the goals of profitability and liquidity

Working Capital Policy (1)


Management of working capital

aggressive policies may involve holding low levels ofcash and stocks, with the risk of potential cashshortages and stock-outsconservative policies may be more flexible with higher levels of cash and stock, giving lower risk at the expenseof reduced profitability

Working Capital Policy (2)


Management of working capital

Effective management and control of stocks requiresits appropriate location and storageestablishment of robust stock purchase procedures and reorder systemsaccurate and timely systems for the recording, controland physical checks of stocks

Stocks Management (1)


Management of working capital

Stock levels may be monitored using the following ratios:stock days = stock value_________or stock average daily cost of sales in periodturnover stock weeks = total stock units_____ average weekly units cost of sales Internal stock utilisation efficiency may be measured usingfinished goodsraw materialswork in progressaverage weekly average weekly raw average weekly despatches material usage production

Stocks Management (2)


Management of working capital

JIT is a management philosophy that incorporates a ‘pull’ system of producing or purchasing componentsand products in response to customer demandin a JIT system products are pulled through the system from customer demand back down through the supply chain to the level of materials and componentsthe consumer buys, and the processes manufacture the products to meet this demand - the consumer therefore determines the schedule

Just in Time (JIT)


Management of working capital

Materials requirement planning MRP (or MRPI) isa system that converts a production schedule into alisting of the materials and components, required tomeet that schedulea system that ensures that adequate stock levels are maintained and items are available when needed

Materials Requirement Planning (MRP)


Management of working capital

Manufacturing resource planning (MRPII) is an expansion of material requirements planning (MRPI) to give a broader approach than MRPI to the planning and scheduling of resources, embracing areas such asfinancelogisticsengineeringmarketing

Manufacturing Resource Planning (MRPII)


Management of working capital

OPT is a philosophy, combined with a computerised system of shopfloor scheduling and capacity planningOPT differs from a traditional approach of balancing capacity as near to 100% as possible and then maintaining flow

Optimised Production Technology (OPT) (1)


Management of working capital

OPT aims to balance flow rather than capacity, and like JIT, it aims at improvement of the production process and focuses on factors such asmanufacture to orderqualitylead timesbatch sizessetup times

Optimised Production Technology (OPT) (2)


Management of working capital

Effective management and control of debtors requires the establishment of appropriate policies coveringthe choice of customersthe way in which sales are madethe sales invoicing systemthe means of settlementthe implementation of a credit management and overdue accounts collection system

Debtors and Credit Management (1)


Management of working capital

Debtor levels may be monitored using the following ratiodebtor days = accounts receivable x 365 sales

Debtors and Credit Management (2)


Management of working capital

Example of an Aged Debtors Report


Management of working capital

although not free, trade creditors provide the company with an additional source of financeeffective management and control of creditors requiresthe establishment of appropriate policies covering the choice of suppliersthe way in which purchases are madethe purchase invoicing systemthe means of settlement

Creditors Management (1)


Management of working capital

Creditor levels may be monitored using the following ratiocreditor days = accounts payable x 365 cost of sales (or purchases)

Creditors Management (2)


Management of working capital

Example of an Aged Creditors Report


Management of working capital

regular measurement of the operating cycle, which determines the short-term financing requirements of the business, enables the company to monitor its working capital performance against targets and identify areas for improvement operating cycle (days) = stock days + debtor days - creditor daysOr alternatively as a percentageoperating cycle % =working capital requirement (stocks + debtors - creditors) sales

Operating Cycle Performance


Management of working capital

Balance Sheet Items that Impact on Short-term and Long-term Cash Flow


Management of working capital

The short-term cash position of an organisation maybe improved by reducing current liabilities, and/orincreasing current liabilitiesstock levelsdebtorscash at bankcreditorsoverdraftstaxationVATPAYE/NIdividends payable

Cash Management (1)


Management of working capital

The long-term cash position of an organisation may be improved by increasing equity, and increasing long-term liabilities, and reducing the net outflow on fixed assets:shareholders’ capitalloansleasing and hire purchasepurchases of fixed assetssales of fixed assets

Cash Management (2)


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